One of Canada's largest mortgage lenders just imploded

Hyungwon Kang/Reuters
One of Canada's largest mortgage lenders just imploded, and it may have serious consequences for Toronto real estate.

Home Capital Group, a publicly traded company that engages in non-prime (a.k.a. subprime) lending, saw its stock drop over 60% in a single day.

The reason? They're facing a liquidity crunch, as their capital for subprime mortgages dried up very quickly.

This could be the start of a broader trend of investors derisking, and it may kill a significant segment of high-leverage buyers.

Home Capital's Massive Drop

The company's stock has been on a steady slide for the past couple of years. It reached a peak of $55.24 a share in August 2014, before tumbling all the way down to $5.99 a share as of yesterday's close. In the process, Home Capital Group has shed an estimated $2.6 billion in market cap, and is now worth just a little over $400 million. It's been a rough couple of years.

Problems at the company first appeared in 2013. That was year that Steve Eisman, yeah - the dude from The Big Short, presented his short thesis on the company's subprime operations. Then last year, former hedge-fund manager/noted short-seller Marc Cohodes called out the company for not cracking down hard enough on known fraud. Sometime this year regulators finally caught up with the issues, and called them out too. Most people thought they were overselling problems at the company… until yesterday.

Home Capital Group Takes Out A Credit Line Of $2 Billion

Shortly before the market opened, Home Capital Group announced it had entered a non-binding agreement for a $2 billion credit line. Turns out in the past 30 days, $591 million in cash was withdrawn from high interest savings accounts leaving them short on capital. This essentially creates a textbook example of a run - which is when a bank sees customers withdraw money all at once. This leaves the bank short on operating capital, forcing them to seek emergency credit lines, have a fire-sale of assets, or both.

In a twist of irony Home Capital Group, a subprime lender themselves, received a credit line with fairly predatory terms. Who supplied the credit is still hush, hush, but they did publish the terms of the deal. Their $2 billion line is subject to an immediate draw of $1 billion, and they will need to pay a $100 million commitment fee. The interest rate on the outstanding credit is 10%, and the "standby fee" for undrawn funds is 2.5%. At those rates, it's pretty difficult to imagine them making substantial money… considering the mortgage lender is paying interest almost 3 times the rate of an average mortgage.

Broader Consequences For The Market

I know what you're thinking, who gives a crap if one bank is imploding before our eyes? However, this might be the catalyst that sends our multi-decade bubble into a headspin. Canadians have become increasingly addicted to sub-prime mortgage borrowing, and it has become a major driver of the Toronto housing market - Home Capital Group's home base. As the lender faces a tougher environment, less loans for subprime borrowers will be available. If Toronto loses a significant number of buyers because they can no longer obtain loans, the market is going to feel that impact.

The circumstances Home Capital Group are entering sounds a lot like the situation with New Century Bank in 2007. New Century was the second largest subprime lender in the US (and smaller than Home Capital Group at peak), and faced a sudden liquidity crunch. No move they could make would help them out, and they eventually filed for bankruptcy in April of 2007.

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